The F Word In Financial Services – And Why You Need To Know It

April 04, 2016

Should financial advisors have to act in the best interest of their clients? Absolutely yes, according to the U.S. Department of Labor. The Office of Management and Budget will soon release the final version of the DOL’s fiduciary rule, which will require more of those who provide retirement investment advice to put their clients’ best interests first by expanding the type of retirement investment advice covered by fiduciary protections. What does this mean, and how will it impact employees saving for retirement?

The term “fiduciary” comes from the Latin word, “fiducia,” meaning trust. A fiduciary must act for the benefit of another person in a financial relationship and not for their own personal gain. Fiduciaries must disclose all conflicts of interest, and have a legal obligation to take into account the beneficiary’s circumstances, goals, risk tolerance, time horizon and investment experience. In other words, when you hire a fiduciary, he or she is legally and ethically required to act in your best interests.

The practical implication of this is that when choosing between two otherwise very similar investments, a fiduciary would choose the one with the lower costs. This is very helpful as the structure of much of the financial services industry is full of inherent conflicts of interest that don’t always favor consumers. A fiduciary can’t charge you ridiculously high commissions on an investment just because they have a mortgage to pay on their second home or their broker-dealer has a current sales promotion with a favored mutual fund company.

But wait…Aren’t all financial advisors supposed to do that anyway? Not to the same extent.

Many financial advisors operate under something called the “suitability standard,” which states that the advisor must have a “reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through reasonable diligence.”  This is why a financial advisor can sell you a mutual fund with a 4% up front sales charge, recommend investment strategies with lagging performance or encourage you to roll over your 401(k) into a higher fee account when you leave a job. Fellow Financial Finesse planner Erik Carter wrote about this conundrum for financial advisors recently in his Forbes column.

Thankfully, there are some financial advisors already follow the fiduciary standard, such as registered investment advisors (RIAs) and certain retirement plan advisors under ERISA, the law that governs employer-sponsored retirement plans. Fee-only financial advisors who are members of the National Association of Personal Financial Advisors sign a Fiduciary Oath as part of their membership. According to the CFP Board, “CERTIFIED FINANCIAL PLANNER™ professionals providing financial planning services also must abide by the fiduciary standard,” acting “solely in the client’s best interest when offering personal financial planning advice,” and the Board has been very active in promoting adoption of the DOL rule and a uniform standard. However, some CFP® professionals work for big financial services firms who have not yet adopted the standard. So what is the new DOL rule likely to mean for retirement savers?

Lower fees

More types of retirement investment advice are covered, including for IRAs and individual work-sponsored retirement plan accounts. This could mean that certain types of investments are less easy to justify selling to retirement investors, such as high fee mutual funds, and may put downward pressure on fees overall. The DOL estimates that expanding who must provide fiduciary advice will save investors up to $40 billion in fees over the next ten years.

Less pressure to rollover your retirement plan to an IRA

According to a recent Wall Street Journal article, the new DOL rule will make it harder for advisers to recommend a rollover of your work-sponsored retirement plan if you leave your job, “as they will have to clearly document why it is in a client’s best interest. Additionally, once the money is in an IRA, advisers would generally have to avoid payments, including commissions, that create incentives for them to select one product over another.”

Rebuilds trust and confidence

The most consumer-friendly aspect of the expanded fiduciary rule is that it aligns the interests of retirement financial advisors and their clients. This eliminates conflicts of interest and gets financial advisors and clients on the same side of the table when it comes to retirement investing. If you know that your advisor is legally looking out for your best interest and not just looking to make a sale, this makes it more likely that you’ll consider his/her advice carefully.

More transparency should rebuild trust and confidence in financial advice. That is good for investors and good for financial services. The DOL rule has prompted the SEC to begin looking at adopting a Uniform Fiduciary Standard for all investment advice, not just retirement advice.

 

 

Can Dr. Seuss Help Us With Financial Literacy Too?

April 24, 2013

Can you remember learning to read? For anyone under the age of 60, it probably started with The Cat in the Hat. Its simple rhymes and fanciful illustrations helped millions of us master our first real book. With that cat, we were phat!  Amazing to consider it, but we were now literate!

April is Financial Literacy Month, but many Americans find that understanding how their finances work is not nearly as easy or fun as reading a Dr. Seuss story. Perhaps it’s the numbers and calculations involved or the inevitable legalese, small print and absence of pictures that make financial literacy such a difficult skill. Nevertheless it is matter of economic survival. If we do not know how the dollars work, we cannot get them to work for us to better our lives. As the hatted Cat might say, “It’s fun to have money, but you have to know how.”

So to recognize the importance of financial literacy, the CFP Board has enlisted the creative genius of Dr. Seuss to help explain a few of the most essential concepts of personal finance. These concepts build on one another like Yertle’s trusty turtles to allow us to see the opportunities and possibilities for creating financial security for ourselves and our families.

Step with care and great tact

and remember that Life’s

a Great Balancing Act.

Balance is a fundamental concept of personal finance. Managing money requires balancing wants with needs, income with expenses, what you own and what you owe, return with risk.  A common mistake that people make with their money is failing to understand this balance. They think their paychecks are entirely for spending today as opposed to saving some for tomorrow.  Similarly, they may choose investments based solely on the promise of a given interest rate, dividend, or possibility of gain without considering the amount of risk they are taking with that investment. Or they may focus only on the risk of loss with an investment, not appreciating that some risk is necessary to growing their wealth.

Do you dare to stay out? Do you dare to go in?

How much can you lose? How much can you win?

Building on the principal of financial balance is the notion of “opportunity cost.”  Whenever we make a financial decision based on its expected benefits, there is always a “cost” for this decision.  Sometimes this cost is an actual amount we must pay, such as a fee or tax. But there is also the cost of other opportunities we cannot pursue as a result of making our decision. For example, if we splurge on a vacation this year, we cannot send the kids to camp. Opportunity cost can also be understood as other possible uses for our money. While those possibilities are limitless, it is nevertheless smart to think about several before making any big decision. What are the implications of “staying out” or “going in”  — be it in the stock market or the job market or your employer’s 401(k)? What do you gain, and what do you stand to lose?

How did it get late so soon?

It’s night before it’s afternoon.

December is here before it’s June.

My goodness how the time is flewn

How did it get late so soon?

Financial literacy is about more than money. Just as fundamentally, it’s about time.  It requires understanding the ebb and flow of financial resources throughout our lives and planning ahead today for what will be needed tomorrow.  Too many Americans are now facing the November and December of their lives – their retirement years – and wishing they had done more preparation and planning while they were still enjoying June.   Preparing a budget, getting the right insurance coverages, and having a plan for funding and meeting future financial goals is the way to move deliberately and confidently into tomorrow, rather than arriving not quite knowing where and how you got there.  While time flies for us all, there’s a big difference between flying straight and careening all over the map.  Those who do their financial planning have a much better sense of where time’s flight will take them.

And it should be, it should be,

It should be like that!

Because Horton was faithful!

He sat and he sat!

He meant what he said

And he said what he meant

An elephant’s faithful

One hundred percent!

Knowing how to find a trustworthy professional to help with personal finance is another important indicator of financial literacy. This isn’t necessarily easy, given the proliferation of credentials and designations used by the 300,000+ financial advisors in the US. Americans need to understand the basis of those credentials: how much education is required? What type of examination must be passed? What are the ongoing requirements for maintaining the certification? Does the advisor commit to a code of ethics? Not getting the answers to these questions can be as dangerous a form of “illiteracy” as is the inability to understand the differences between a stock and a bond.

Most important of all is the knowledge of a given financial advisor’s obligation to his or her client. Does the advisor, like Horton, take on a “duty of care” for the client? Are they open and honest in what they say to clients or prospects, fully explaining the basis of their advice and disclosing any potential conflicts they might have?

Some financial advisors are held to these types of standards as a condition of their professional practice. CFP® professionals and Registered Investment Advisors are two such types of advisors.  You can save yourself a lot of needless memorization of other names and letters by keeping your focus on these advisors for your financial planning and investment advice.

At the CFP Board, we realize that becoming financially literate is not always fun or easy. But it is definitely empowering. Taking a first step, like signing up for a personal finance class or visiting www.letsmakeaplan.org to learn more about financial planning can be the start of an amazing journey to financial security.  In the words of  Dr. Seuss:

The more that you read,

The more things that you know

The more that you learn

Oh the places you’ll go!

 

 

 

 

 

2013: IN WITH THE NEW, BUT NOT OUT WITH THE OLD

December 26, 2012

There are two ways to greet the New Year.  One is to look to the new places, people, and possibilities to come.  The other is to take long, nostalgic glances at the past and remember the best of days gone by. I am firmly in the latter camp.  I can think of no better way to celebrate the fact that for the next few months I will have to tear up all those misdated checks than to sit quietly at home watching my favorite old movies. Continue reading “2013: IN WITH THE NEW, BUT NOT OUT WITH THE OLD”